Dual SMSF investment strategy that ticks all boxes

Key point: Your DIY fund’s approach to diversification needs to act a benchmark for your auditor as well as offer you flexibility with the best direction for members.

Note: This article by Tim Mackay was originally published in the Australian Financial Review. You can view it on the AFR website [here] ($paywall).


Recently the ATO sent a letter to 3 per cent of self-managed superannuation funds (SMSFs) asking: “Is your SMSF investment strategy meeting diversification requirements?”

If you’re among the majority of SMSF investors who didn’t receive one, you’re probably scratching your head wondering why so much time has been dedicated to a seemingly peripheral issue. It’s a good question.

In reality, the letter is important to those who received it and those who didn’t.

For those who didn’t receive a letter, the ATO’s question assumes three things: you have an investment strategy; you know what the diversification requirements are; and you meet those diversification requirements.

Legally, every SMSF must have a documented investment strategy. The regulations require you to have one and, what’s more, you have signed a trustee declaration confirming you have an investment strategy.

The regulations also list what to document in your investment strategy: investment risks; likely returns you seek; liquidity (how easily you can sell investments); the need for insurance; and, most important, the fund’s approach to diversification.

The financial term “diversification” means don’t put all your eggs in one basket. Complex mathematical methods show diversification makes sense, as does spreading your investment across asset classes.

Dual strategy

Where it becomes grey is that your SMSF investment strategy needs to meet two different objectives.

From your auditor’s perspective, they need to verify that your SMSF has met the conditions of your investment strategy every year.

From your perspective, you want a documented SMSF investment strategy that gives you direction with flexibility and meets the rules.

So after documenting asset classes your SMSF can invest in (for example, cash and cash equivalents, fixed income, property, Australian equities, international equities and alternatives), you might specify an allowable range of 0 to 100 per cent for each asset class for flexibility.

However, a cynic could argue that this flexible approach is taking the mickey in terms of compliance. Such a wide range gives no practical investing direction and could be seen as a compliance tick-a-box motion.

So what if instead you develop a practical, useful investment strategy?

Let’s assume your SMSF has a balanced growth profile with a 70:30 split between growth and defensive assets.

Benchmark ratios

Across asset classes you could target cash and cash equivalents 3 per cent; fixed income and term deposits 27 per cent; property 14 per cent; Australian equities 28 per cent and international equities 28 per cent. Then you could give yourself about 10 per cent leeway for each asset class.

These are well-defined targets that enable good investment decision making. They are stakes in the ground that allow you to objectively compare your asset allocation over time, independent of emotions and market volatility.

However, this approach could box your SMSF and your auditor into a legal corner.

If market conditions or your own circumstances change, switching entirely to cash may be a prudent decision. Or business owners buying their own premises comprising 95 per cent of fund assets may be a prudent decision.

But if your documented diversification rules don’t allow it, your auditor cannot verify you’ve met fund rules at all times.

This trade-off between flexibility and investment direction creates an inherent conflict. So how do you solve a problem like an investment strategy?

I think you need to have two. A formal document that gives you maximum flexibility to act decisively in the members’ best interests and, within it, a more detailed asset allocation exercise that you undertake, say, twice a year where you do the detailed comparison. It’s a bit more work but it neatly solves the dilemma trustees face.

And for those who received the ATO letter? In reality, it’s not people with 100 per cent cash – it’s those exposed to a single leveraged property and not much else. So the problem is less diversification and more the type and risk of the asset.

You must identify the risks created by asset concentration and have a documented Plan B if things go wrong. In giving this warning, the ATO has covered itself should things go systemically wrong in this area. Trustees must do the same with their documented SMSF investment strategy.


Tim Mackay is an independent advisor at Quantum Financial. You can view his personal website at www.theindependentfinancialadvisor.com.au


Claire Mackay

About Claire Mackay

I am a financial planner, SMSF expert and company director. I thrive on providing independent, expert financial advice to my wonderful clients. I was recognised as Financial Planner of the Year 2015 and Investment Adviser of the Year 2014. My website is here

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